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When you are struggling financially, there can be a temptation to cancel or delay loan installments. The idea that this may give you some “breathing space” is unfortunately fatally flawed. As we will cover in this article, most lenders will try to help where you are experiencing financial difficulties. However, if you suddenly stop paying your loans without any communication or warning, there are potentially severe consequences.
- Why would a lender look to help you?
- How would a lender react if you stopped paying your loans?
Why would a lender look to help you?
Before we look at the numerous actions that a lender might take if you stop paying your loan, it is worth taking a step back. Why would a lender potentially help you if you approached them about financial difficulties?
The process of pursuing a customer for funds that they are unable to repay at this moment in time is costly. While it would depend upon the level of funds outstanding, there are situations where it could cost more to pursue a debt. Consequently, lenders are often happy to look at alternative options that could avoid short-term cash flow issues spiraling out of control. We will take a look at the options available towards the end of this article, but now we will look at what happens if you just stop paying your loans.
How would a lender react if you stopped paying your loans?
There is a process that lenders have to follow if their customers suddenly stop with their loan repayments. The idea is simple, short-term financial penalties will, in many cases, prompt customers to get back on track as soon as possible. If they cannot afford the repayments, there are other options, as we touched on above.
Deep in the small print of your loan agreement will be details of an array of additional charges if you are late with your loan repayments. Depending upon the type of lender, type of loan, and amount involved, you may have two or three months to reorganise your finances and restart repayments. However, unless you come to a prior agreement with your lender, you will likely see an array of additional charges.
Increase in interest rate
There will also be situations where a lender will move you to a higher interest rate if you suddenly stop paying back your loan. This is simply a reflection of the risk/reward ratio, and while it may seem strange to increase the interest rate for someone who has defaulted on repayment, this is standard practice. If a customer couldn’t make any further repayments, the additional charges and adjusted interest rate would be part of any final legal settlement.
Credit rating agencies
All developed financial markets worldwide depend upon the input of credit rating agencies when assessing the risk/reward ratio for any transaction. So, as soon as you stop paying your loans, this will trigger a chain of events that would eventually see your default reported to credit rating agencies. As we touched on above, depending upon the lender, you may have one month, two months, or three months before they take any action. It is not simply a case of one strike, and you are out.
Joint loans – the liability conundrum
There is a common misconception that each participant is liable for “their share”. Each party would contribute the same amount to monthly repayments in a perfect world until the loan was eventually repaid. Unfortunately, this is not always the case.
If you have a joint loan and the other party defaults on their “share of repayments”, the lender has the legal option to pursue you for the entire outstanding amount. This would be a viable option if the lender believed that you could make the necessary repayments. It would then be up to you to organise any financial compensation with the other party to the loan. As far as the lender is concerned, the entire liability has switched to you. So, it is essential to note that, legally, you are both liable for the total amount when taking out a joint loan.
Calling in security
Whatever type of loan, whatever your situation, if you can provide additional security against a loan, this reduces the risk/reward ratio. The reduction in the risk/reward ratio would allow you access to beneficial interest rates and may even increase the maximum loan amount. The idea is simple; you fulfill your loan repayments until the debt is repaid in full, retaining the security put up against the loan.
If you were to default on the loan, and you were unable to agree on an alternative arrangement with your lender, there is every chance they could call in the security. A lender would be looking for repayment as soon as possible and may pursue a “fire sale”. In this scenario, the asset could be sold at less than the actual market value. If the sale raised enough to cover the outstanding debt, you would receive any excess funds. On the other hand, if the deal failed to raise sufficient funds to repay the debt entirely, you would still be liable for the remaining amount.
Offering an asset as security against your loan is a perfectly acceptable means of reducing interest and maximising your loan amount. However, you need to be careful!
Calling in a guarantor
There is an old saying, never mix business with pleasure. This has never been more apt for many people than when using a family member, friend, or colleague as a guarantor for a loan. Unfortunately, many promises have been broken, friendships ruined, and finances crippled when the borrower defaults.
When it is evident that the original borrower cannot fulfill their financial obligations, the onus will then switch to the guarantor. It will depend upon the attitude of individual lenders, but they could ask a guarantor to continue with monthly repayments or pay the outstanding balance in full. Whatever happens, if you have signed up as a guarantor to a loan and the borrower has defaulted, the lender will come after you. Any action that you take against the borrower is irrelevant in the eyes of the lender. When they default, you take on the responsibility.
Insolvency and bankruptcy
Insolvency and bankruptcy laws vary worldwide, but they are viable options for those suffering severe financial distress. An insolvency arrangement would likely see you agree to a repayment plan with all of your creditors, not just the lender in question. Usually, if you default on one loan, the chances are you will default on other outstanding debts. They can soon mount up!
In some situations, an insolvency arrangement might be irrelevant with the individual’s financial health in decline. Consequently, bankruptcy may be the only real option and one that would wipe out any debts owed. This is often a means of allowing the individual to “start again” with no financial liabilities, but there would likely be restrictions. In many countries, the attitude of the courts is simple. If there is no likelihood of repayment, there is no reason to pursue the individual. There are knock-on effects to credit ratings and access to finance in the future.
Speak to your lender if encountering financial problems
If you suspect you may soon encounter cash flow/financial problems, it would be sensible to seek a meeting with your lender. If possible, approach them with a short to medium-term plan to address your financial issues. They may be receptive to:-
- Repayment holidays
- Reduction in short-term repayments
The cost of taking action against customers who default on their loans can be relatively expensive, with no guarantee of repayment in full. Consequently, a short-term reduction in financial repayments can often give people time to get back on a firmer financial footing. This means that the lender will receive reimbursement in full, the borrower avoids any further knock-on effect, and there is often no reason to inform the credit rating agencies.
Unfortunately, many people tend to bury their heads in the sand when they see financial challenges on the horizon. In this situation, it is likely to get worse before it gets better. The longer you leave it to inform your loan provider of your issues, the fewer options available and the more likelihood of further financial distress.
Many people will experience a degree of financial distress at some point in their life, impacting their cash flow and ability to make loan repayments. If this is the case, it is in the best interests of both borrower and lender to try and find some middle ground to avoid a worst-case scenario. As we touched on above, the cost of pursuing those suffering financial distress for repayment of outstanding debts can be expensive with no guarantee of repayment.
Therefore, it makes sense that lenders would prefer to agree on a formal arrangement to try and head off any serious financial issues further down the line. Many people fail to appreciate the potential knock-on effect to other debts and the vast mental trauma that can follow. So, be honest with your lender, present a plan where possible, and better manage your assets and finances in the future. There are more options than you probably think!
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